Johns Hopkins University v. Hutton

• Decision Date: 18 February 1970
• Docket Number: No. 13293.,13293.
• Parties: The JOHNS HOPKINS UNIVERSITY, Appellee, v. William E. HUTTON et al., Appellants.
• Court: U.S. Court of Appeals — Fourth Circuit

422 F.2d 1124 (1970)

The JOHNS HOPKINS UNIVERSITY, Appellee, v. William E. HUTTON et al., Appellants.

No. 13293.

United States Court of Appeals, Fourth Circuit.

Argued November 5, 1969.

Decided February 18, 1970.

COPYRIGHT MATERIAL OMITTED

John F. King, Baltimore, Md. (John A. Wilson, Michael J. DeSantis, Robert A. Butler, and Shearman & Sterling, New York City, on brief) for appellants.

John Henry Lewin and Edmund P. Dandridge, Jr., Baltimore, Md. (Venable, brief), for appellee. Benjamin C. Howard, Royall, Koegel & Wells, Baltimore, Md., Bardusch, Johnson, Scheminger & Duncan, New York City, on brief for Ragnar D. Naess, and Naess & Thomas.

Before BOREMAN, BRYAN, and BUTZNER, Circuit Judges.

BUTZNER, Circuit Judge:

Johns Hopkins University brought this action against the partners of W. E. Hutton & Co., a stock brokerage firm, to rescind Hopkins' purchase of an oil and gas production payment from Trice Production Co. After extensive pretrial litigation, the district court (Kaufman, J.) granted Hopkins' motion for summary judgment on the ground that Hutton's employee, Gilbert H. LaPiere, had violated Section 12(2) of the Securities Act of 1933.¹ Johns Hopkins University v. Hutton, 297 F.Supp. 1165 (D.Md.1968). We hold genuine issues of material fact preclude the entry of summary judgment on the issue raised by Hutton's plea of the statute of limitations. On all other issues, the district court correctly entered summary judgment for Hopkins.

I.

The initial question presented by this appeal is whether the court erred in holding that the production payment met the statutory definition of a security. Hutton contends that as a matter of law it is not a security, and that in any event the question is beclouded by disputed issues of fact which should be submitted to a jury.

Production payments are frequently used financing devices in the oil and gas industry. The payment Hopkins purchased from Trice represented an interest in oil and gas reserves in the ground to be extracted from 23 specified wells. Trice, which retained an interest in the properties, agreed to extract and market the oil and gas and pay the proceeds from Hopkins' share to Hopkins until it recovered its purchase price of $1,300,000. Also, Trice agreed to pay Hopkins from the production of the wells 6% return on the unpaid balance of the purchase price and a specified percentage of the net profit. Since certain of the wells were subject to a prior production payment, Trice guaranteed payment of the 6% return until the underlying production payment terminated.

The sale of Hopkins' production payment was not an isolated transaction. Trice sold two production payments to another investor and a second payment to Hopkins. Trice and LaPiere also sought to persuade a number of prospective investors, individually or through a syndicate, to purchase others. In all Trice planned to sell production payments in the amount of about $10,000,000.

Section 2(1) of the 1933 Act,² defines "security" as, among other things, an investment contract. And though the device be novel or uncommon, it may qualify as a security if, as a matter of fact, it has been "widely offered or dealt in under terms or courses of dealing which established its character in commerce as an `investment contract' * * *." S.E.C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943). The definition of an investment contract found in S.E. C. v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), embraces Hopkins' production payment. There the Court, teaching that form should be disregarded for substance and that emphasis must be placed on economic reality, said:

"An investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise. * * * It embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits."

The fact that Hopkins' production payment is unique because it deals, as do production payments generally, with specific wells does not exclude it from coverage of the Act. The transactions in Howey coupled the sale of acreage in a citrus grove with service contracts for the cultivation, harvesting, and marketing of the fruit. Since each sale involved a different plot of the orchard ranging in size from less than an acre to more than five acres, it is apparent that each investment contract was novel. Nevertheless, the Court held that the transactions were subject to the Act.³

Nor does the fact that Hopkins would not have purchased the production payment without Trice's guarantee preclude summary judgment on this issue. The definition of a security expressly includes a guarantee of any of the other devices enumerated in Section 2(1).⁴ Therefore, a guarantee cannot have the effect of denying coverage to an instrument that otherwise satisfies the Act's definition of a security. Whether the guarantee is a part of the production payment or collateral to it is immaterial. In either event the entire transaction, including the guarantee, falls within the statutory definition of a security.

We conclude, therefore, that the district court correctly held as a matter of law that Hopkins' production payment was an investment contract within the meaning of the Act because it involved "an investment of money in a common enterprise with profits to come solely from the efforts of others," S.E.C. v. W. J. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244 (1946), and because it satisfied the common offering and trading requirements set forth in S.E.C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S.Ct. 120, 88 L.Ed. 88 (1943).

II.

Judge Kaufman properly analyzed and applied Section 12(2) of the 1933 Act, saying:

"Hutton violated Section 12(2) if, as a broker, it offered or sold to Hopkins, a security as defined by Section 2(1) of the \'33 Act using the mails, or an instrument of, or communication in, interstate commerce to accomplish the same, by means of an untrue statement of material fact or by omitting to state a material fact necessary in order to render the statements Hutton made not misleading under the circumstances in which the statements were made; provided that Hopkins did not know of such untruth or omission, and that Hutton knew, or in the exercise of reasonable care, could have known of such untruth or omission * * *." 297 F.Supp. at 1208.

There can be no doubt that Hutton, a broker acting through LaPiere, offered and ultimately sold to Hopkins a security by using the mails or other means of interstate communication. There is also no doubt that significant — indeed probably the most important — information for Hopkins to consider in purchasing the production payment was the future net revenue for the 23 wells underlying the payment, for it was from this revenue that Hopkins expected to recoup its investment and make a profit. The amount of the future net revenue could not be measured; it could only be estimated, and the reliability of the estimate rested upon the judgment of the estimator. DeGolyer & MacNaughton (D & M) was among the most respected engineering firms engaged in supplying independent estimates of the worth of oil and gas properties. Trice furnished Hopkins a brochure which showed the estimate of the total future net revenue for all 23 wells to be $6,500,000. LaPiere represented that this estimate was made by D & M. LaPiere also represented that the D & M estimate showed a return of $2,905,000 as Hopkins' share of the future net revenues. LaPiere, however, knew that D & M had neither estimated all of the wells nor provided a basis for calculating Hopkins' share of the future net revenues. Moreover, LaPiere omitted to tell Hopkins that in order to show future net revenues of $6,500,000 it was necessary to substitute for conservative estimates on some of the wells higher estimates from other sources.

The district court held, and we agree, no genuine issue of fact was presented concerning the materiality of LaPiere's misrepresentations and omissions. A fact is material if it concerns information about which "an average prudent investor ought reasonably to be informed before purchasing the security * * *." Demarco v. Edens, 390 F.2d 836, 840 (2d Cir. 1968), citing 17 C.F.R. § 230.405(1). Or, as formulated by the Restatement of Torts § 538(2) (a) (1938): "A fact is material if * * * its existence or nonexistence is a matter to which a reasonable man would attach importance in determining his choice of action in the transaction in question * * *." The materiality of LaPiere's misrepresentations and omissions becomes readily apparent by comparing the estimate of future net revenues of $6,500,000 he vouched to Hopkins with the estimate of $5,355,744 Trice and LaPiere had previously furnished another investor. Clearly, a "reasonable man would attach importance" to this discrepancy of over a million dollars. Also, an "average prudent investor" ought reasonably to have been informed that independent appraisers furnished much lower estimates on some of the wells than the figures used to compile the total of $6,500,000.

Generally the issue of materiality, resting as it does upon the reaction of a "reasonable man," cannot be decided by summary judgment. Rogen v. Ilikon Corp., 361 F.2d 260, 265 (1st Cir. 1966). But here the discrepancies in basic data are so large, and the facts misrepresented and withheld are so obviously important to an investor, that reasonable minds cannot differ on the question of materiality. Since the...